A term sheet is a non-binding document outlining essential terms for a prospective contract. Commonly used in venture capital and similar business financing, term sheets help to establish clear expectations and ensure that all parties to a contract under consideration share an understanding of timelines, payment amounts, and the duties and responsibilities each party will assume once the contract has been signed. While a term sheet is no substitute for a carefully drafted and vetted, legally binding contract, reaching consensus on a term sheet generally marks a significant milestone in the contract negotiation process. To learn more, or to discuss your term sheet needs with an experienced contract and business law attorney in Louisiana, book a consultation with Business Law Group by calling (504) 446-6506 today. 

Term Sheet vs. Contract 

Many entrepreneurs at the outset of their business journeys have questions about the differences between term sheets and business contracts. The two documents do cover generally similar information, and are frequently used in similar types of business arrangements. The key differences lie in their ability to legally "bind" participants, the level of detail with which information is presented, and the stage of business negotiations at which each document is used. 

Binding vs. Non-Binding 

A contract, once signed, is usually legally binding. While drafting errors can sometimes result in an unfortunate situation in which some or all of a contract's terms may be found to be legally unenforceable, in general signing a contract constitutes accepting legal responsibility for abiding by whatever requirements are set out in its terms. When a dispute arises because one party to a contract believes that the other is not fulfilling its portion of the agreed-upon terms, the dissatisfied party will often file a civil lawsuit seeking compensation for damages, injunctive relief, or both. 

A term sheet is not usually held to be legally binding (or "enforceable"). Rather than constituting a set of terms by which both parties are agreeing to be held legally responsible, a term sheet aims to set out the key points to be covered in the finished contract in order to establish, before moving forward, that all parties are "on the same page" with respect to essential considerations. 

Detail of Information 

A term sheet is, as its name suggests, often a single-page document. As such it will not contain the intricacy of detail expected of a comprehensive business or investment contract. Instead, a term sheet will typically present a short, "at-a-glance" summary of core elements of an agreement under consideration. If the deal proceeds, these elements will be elaborated – often by business law attorneys – in the completed contract, which all parties will still need to review thoroughly before signing. 

Stage of Negotiations

Term sheets are most often used early in the process of negotiating a business deal. They are common at the outset of venture capital financing arrangements, setting out the amount of capital the investing firm will supply, the timeline for repayment, and any rights conferred by investing (such as shares in the company, often accompanied by voting rights). When term sheets are used for non-investment contracts, such as merger and acquisition (M&A) agreements, these documents may be drafted after an initial round of negotiations, establishing in writing a set of core considerations that the parties have agreed will make the deal acceptable to them – but in general a term sheet will still be among the first documents introduced. 

Relationship Between Term Sheets and Contracts 

Term sheets and contracts do cover generally similar categories of information. However, contracts articulate the terms of an agreement in exhaustive detail, with an aim toward preventing ambiguity and ensuring that the contract, once signed by all parties, will be legally enforceable. Like contracts, term sheets are usually drafted only once some level of consensus has been reached – but term sheets outline the points involved with much less detail, and still permit either party to "go back" or withdraw from the deal, even though this outcome is not usually expected once the term sheet has been introduced. 

Both documents serve needed, but separate, functions in a variety of business negotiations, but particularly in financing and M&A agreements. If you have questions about how to use term sheets effectively as you scale your business ventures, an attorney with Business Law Group may be able to provide you with information and perspective tailored to your industry and circumstances.

Term Sheets in Venture Capital Financing 

A venture capital term sheet is a document, usually consisting of a single page, that outlines the key terms of an investment. Like contracts, term sheets can be signed. Unlike signing a contract, however, signing a term sheet indicates seriousness of intent and affirms the signatories' acceptance of the broad outline of the deal as presented on the sheet. In this sense it serves a function similar to that of a letter of intent, which may or may not also be used.

Items commonly included in term sheets for business financing include: 

• A valuation of the business prior to the investment 

• Preferences for non-participating liquidation 

• Any provisions for anti-dilution (to protect existing investors or the prospective financier) 

• Pay-to-play provisions 

• Rights to boardroom control or participation 

• Specifications for handling stock dividends 

• Voting rights conferred by investment 

• A "drag-along" provision limiting shareholders' ability to block a future sale of the company 

Venture Capital Term Sheets and Investor Control

As the United States Small Business Administration explains, one of the ways venture capital financing tends to differ from other forms of business financing for startups is that venture capital investors usually expect, or even require, a substantial degree of control over the company's direction in exchange for their investment. As a result, many of the terms that regularly appear in term sheets for financing startup businesses will revolve around the kind and extent of control the investor achieves. 

Business Valuation and Foreseeable Outcomes 

Generally speaking, venture capital term sheets cover information related to how much the business is worth before the investment, the scope of control the investor will gain over the company by their investment, and how major foreseeable changes, such as the future sale of the business or change in leadership, will be handled. While none of these categories can be covered as comprehensively in a term sheet as in a finished contract, establishing the essentials in the term sheet helps to ensure that all parties are operating from the same set of agreed-upon premises as they move forward with drafting the contract and closing the deal. 

Term Sheets in Mergers & Acquisitions 

In addition to their use in venture capital agreements for startup businesses, term sheets are also commonly used in M&A negotiations. If you are considering selling your business, or if you are thinking of expanding operations by purchasing an existing business, the term sheet gives stakeholders a chance to review the prospective terms early in the negotiation process. A clear, concise term sheet allows all parties to see the broad outline of the deal under consideration, and provides an opportunity for either party to raise any concerns that have not already been addressed in the initial discussions. 

Term Sheet Checklist for M&As

The items included will depend to some extent on the type of business and whether the anticipated transaction aims to consolidate two companies via merger vs. one company purchasing the other and maintaining separate operational protocols, but term sheets for M&As often address: 

• Business valuation

• Purchase price (usually based on valuation) 

• Employee retention, dismissal, or transfer arrangements 

• Amount and release date of any "holdback" or escrow portion of the purchase price 

• Exclusivity of negotiations 

• Confidentiality of negotiations 

Term Sheet Enforceability and Louisiana M&A Restrictions 

One important point to note is that, while the term sheet as a whole will not usually be considered legally binding or enforceable, provisions for exclusivity (preventing the selling party from negotiating alternative deals simultaneously in an effort to "shop" for higher purchase prices or more favorable contract terms) and confidentiality (preventing either party from revealing the details of the bargain before the contract has been finalized and signed) are generally held to be binding. Signing the term sheet is therefore an important milestone that provides both parties with a measure of security for the final stages of contract preparation. 

All Louisiana mergers and acquisitions involving corporations are subject to § 51:125 of the Louisiana Revised Statutes, which prohibits a variety of business transfer arrangements that might unduly limit fair competition in the marketplace. Before embarking on any contract discussion for the potential sale, purchase, or merger of a Louisiana business, you may wish to consider working with a business law attorney who can review the circumstances of both companies and assess whether the planned transaction may pose risks of regulatory denial. 

Learn More From a Louisiana Business Law Attorney 

While M&As and business startup financing are among the most common applications for term sheets, these documents may be used in almost any business situation that demands shared clarity on essential points in an agreement before the parties move ahead with the often expensive process of preparing and reviewing a legally binding contract. To receive advice and support tailored to your circumstances, or to seek assistance drafting your own term sheet, consider reaching out to Business Law Group. Call (504) 446-6506 today to schedule your consultation.